Chang Wei Liang FX Strategist weiliang.chang@mizuho-cb.com Mizuho Bank, Ltd. Asia & Oceania Treasury Department Mizuho Insights (Ref: MI170914) September 14, 2017 IDR: Unshackled Bank Indonesia (BI) has turned less cautious over IDR appreciation, and is stepping back to allow USD/IDR to trade below the psychological 13300 line. We think key catalysts for this change are increased buffers given a weakened IDR on a trade-weighted basis, sufficiently high FX reserves, and improved banking liquidity evident from a sharp decline in JIBOR rates. Lower interbank rates, and correspondingly better monetary policy transmission, could be seen to diminish the benefit of further expansion in liquidity via BI s FX purchases. Thus, we see scope for USD/IDR to dip further given increased latitude from policymakers. Notwithstanding this, USD/IDR could remain supported above 13000 for the year, amidst lingering concerns over growth and renewed equity outflow pressures. Breaking the habit USD/IDR has recently breached the 13300 barrier, which has previously marked a lower bound of trading ranges since November (see Figure 1). 13800 13700 13600 13500 13400 13300 13200 13100 13000 12900 Fig 1. USD/IDR traded below 13,300 USD/IDR - Monthly Trading Range 12800 Mar 16 Jun 16 Sep 16 Dec 16 Mar 17 Jun 17 Sep 17 Month High Month Low Month Average 1 Breaking the habitual range
The inability of USD/IDR to break significantly below 13300 in the past, despite months of foreign bond inflows, appears largely due to offsetting FX purchases by Bank Indonesia (although BI has sometimes capped USD/IDR upside as well). From BI s reserves data, we estimate that cumulative net FX purchases by BI from Dec-16 to Jul-17 exceeded foreign portfolio inflows by about $1.9bn (see Fig. 2). This explains why USD/IDR has held above 13300 for some time, even as regional USD-AXJ crosses have been slipping throughout this year. Fig 2. BI has sold IDR to offset portfolio inflows 6000 Indonesia -Foreign portfolio inflows vs Est FX reserve buying (USD mn) 4000 2000 0-2000 -4000 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Foreign Bond Inflows Foreign Equity Inflows Est. FX Reserves Buying The times they are a-changin Circumstances have also changed for BI to ease off from selling IDR and accumulating FX reserves, we think. For one, the USD has already weakened broadly during this period, and thus a semi-pegged IDR is now much weaker on a trade-weighted valuation basis, which might be viewed as offering stronger buffers against advanced economies policy normalization. BI s reserves have also climbed due to its FX purchases, and would be sufficient to cover about 280% of short-term private external debt. Thus, the precautionary motive for further reserve accumulation is also turning less exigent at the same time. Fig 3. BI s FX reserves stand at record high Indonesia - FX reserves (USD bn) 130 110 90 70 50 30 10-10 Mar 10 Mar 11 Mar 12 Mar 13 Mar 14 Mar 15 Mar 16 Mar 17 FX Reserves (USD bn) Short-term Private External Debt (USD bn) 2
A second (and understated) consideration for actively purchasing FX is the salutary effect in terms of boosting liquidity in the banking system, where stubbornly high rates have been a hindrance for policy transmission since 2013. The taper tantrum and commodity market stresses have led to a widening spread between 3M JIBOR and the overnight BI deposit facility rate (see Fig 4), reflecting both a tightening of liquidity conditions from capital outflows on top of a rise in credit risk premiums. Fig 4. JIBOR-ON spread has narrowed in August 9.00 JIBOR rates vs BI deposit rate 8.00 7.00 6.00 5.00 4.00 3.00 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 17 BI deposit facility rate 1M JIBOR 3M JIBOR Fortunately, banking system liquidity has become increasingly flush since November, while broader credit risk concerns also appears to be normalizing as new NPL formation has slowed. Combined with a benign flow environment and BI s policy easing in August, these have led to a sharp decline in JIBOR rates in the last month. In fact, the 3M JIBOR-Overnight Deposit Facility rate spread has now narrowed to its lowest level since July 2015 not quite mission accomplished but still marking substantial progress. With 3M SDBI yields also showing a decline of around 60bps since August, we think markets could be pricing in another BI rate cut next week. That said, the decline in 3M JIBOR rates is far larger than this, and firmly indicates that the credit risk premium has already narrowed quite significantly. Given that monetary policy transmission is being bolstered by the sharp fall in interbank rates, continuing sizeable FX intervention might be perceived as being less impactful and less necessary. This could be another reason nudging BI to raise the hurdle for FX control - in effect unshackling USD/IDR and giving it increased latitude to ease in line with broad USD trends. 3
Unshackled, but not unbounded Even as we expect USD/IDR to ease further without shackles, there are three lingering concerns that would argue for BI to maintain a watchful eye, and perhaps intermittently lean against excessive IDR gains. Firstly, from a valuation perspective, IDR is not manifestly undervalued given the stage of the commodity cycle (see Fig. 5), and thus scope for catch-up gains with the rest of USD/AXJ might be lacking. Secondly, overt IDR strength might be viewed as being incompatible with the current policy thrust to lift growth. Any excessive IDR appreciation might also elevate risks of disruptive unwinds that are undesirable. In this context, BI might temper against excessive IDR gains, or could even consider further rate cuts to support growth, taking the wind out of IDR sails. Finally, equity outflow pressures have been intensifying since May. (see Fig 6). While equity flows are typically smaller relative to bond flows, persistent outflows should still give pause to unrestrained IDR gains for now. Furthermore, there are growing market concerns that OJK could re-tighten rules that were previously relaxed for loan restructuring in 2015, which would result in an increase in NPL recognition. Given the above factors, we think USD/IDR could remain supported above 13000 for this year. Fig 5. IDR is not materially undervalued for a large catch-up -40% -30% -20% -10% 0% 10% 20% 30% 40% IDR Model Valuation vs Commodity Price Index IDR undervalued from 1998-2006 given stagnant commodities 50% IDRuplift from 2007-2013 on 60% buoyant commodity prices 4.2 98 00 02 04 06 08 10 12 14 16 18 USD/IDR valuation (inv) Real Commodity Index (rhs, log scale) 6.2 5.8 5.4 5.0 4.6 Fig 6. Equity outflows could continue to pressure 20 Indonesia - USD/IDR vs Foreign Equity Inflows 11000 15 11500 10 12000 5 12500 0 13000-5 13500-10 14000-15 14500-20 15000 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Oct 17 Foreign equity inflows (20dma, ann.) USD/IDR (rhs, inverted) 4
Important Information This publication has been prepared by Mizuho Bank, Ltd. ( Mizuho ) and represents the views of the author. It has not been prepared by an independent research department and it has not been prepared in accordance with legal requirements in any country or jurisdiction designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Disclaimer Unless otherwise stated, all views or opinions herein are solely those of the author(s) as of the date of this publication and are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, and are subject to change without notice. This publication has been prepared by Mizuho solely from publicly available information. Information contained herein and the data underlying it have been obtained from, or based upon, sources believed by us to be reliable, but no assurance can be given that the information, data or any computations based thereon are accurate or complete. This publication provides general background information only. It is information in summary form and does not purport to be complete. This publication has been prepared for information purposes only and is not intended by Mizuho or its affiliates to constitute investment, legal, accounting, tax or other advice of any kind and all recipients of this publication are advised to contact independent advisors in order to evaluate the publication, including, without limitation, the suitability of any security, commodity, futures contract or instrument or related derivative (hereinafter, a financial instrument ), product or strategy herein described. This publication is not intended to be relied upon as advice to investors or potential investors and does not take into account investment objectives, financial situation or needs of any particular investor. It is not intended for persons who are Retail Clients within the meaning of the United Kingdom s Financial Conduct Authority rules nor for persons who are restricted in accordance with US, Japanese, Singapore or any other applicable securities laws. This publication has been prepared for information purposes only and is not intended by Mizuho to market any financial instrument, product or service or serve as a recommendation to take or refrain from taking any particular course of action or participate in any trading or other strategy. This publication is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or any of the assets, businesses or undertakings described herein, or any other financial instrument, nor is it an offer to participate in any trading or other strategy, nor a disclosure document under applicable laws, rules, regulations or guidelines. Nothing contained herein is in any way intended by Mizuho or its affiliates to offer, solicit and/or market any financial instrument, product or service, or to act as any inducement to enter into any contract or commitment whatsoever. Neither the author, Mizuho nor any affiliate accepts any liability whatsoever with respect to the use of this publication or its contents or for any errors or omissions herein. Mizuho and its affiliates, connected companies, employees or clients may take the other side of any order by you, enter into transactions contrary to any recommendations contained herein or have positions or make markets or act as principal or agent in transactions in any securities mentioned herein or derivative transactions relating thereto or perform or seek financial or advisory services for the issuers of those securities or financial instruments. All of the information contained in this publication is subject to further modification without prior notice and any and all opinions, forecasts, projections or forward-looking statements contained herein shall not be relied upon as facts nor relied upon as any indication of future results. Opinions stated in this publication are subject to change without notice. Future results may materially vary from such opinions, forecasts, projections or forward-looking statements. The information contained in this publication may not be current due to, among other things, changes in the financial markets or economic environment. Mizuho has no obligation to update any information contained in this publication. Past performance is not indicative of future performance. This is a strictly privileged and confidential publication. This publication contains information addressed only to a specific individual and is not intended for distribution to, or use by, any person other than the named addressee or any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Save with Mizuho s prior written consent, you may not disclose, divulge, reproduce or furnish any information contained herein to any other party. Please notify the sender immediately if you have mistakenly received this publication. Singapore: Mizuho is licensed as a bank under the Banking Act (Chapter 19) of Singapore, and is regulated by the Monetary Authority of Singapore. Japan: Mizuho is authorised and regulated by the Financial Services Agency of Japan. United Kingdom / European Economic Area: In the UK, Mizuho is authorised by the Prudential Regulation Authority and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of MHBK's regulation by the Prudential Regulation Authority are available upon request. This publication may also be distributed by Mizuho International plc ( MHI ). MHI is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. United States: This publication is not a research report as defined in Commodity Futures Trading Commission ( CFTC ) Regulations 1.71 and 23.605. The content of publications distributed by Mizuho Securities USA Inc. ( MSUSA ) is the responsibility of MSUSA. The content of publications distributed directly to US customers by Mizuho is the responsibility of Mizuho. US investors must effect any order for a security that is the subject of this report through MSUSA. 2014 Mizuho Bank Ltd. 5